Gazprom, Statoil, LNG Producers and Transporters Will Benefit From Europe’s Gas Woes
Europe is facing a multilateral squeeze on the natural gas front. This has interesting implications from an investor’s perspective.
Eurozone Economy Gathers Steam
On one side, demand is set to increase as the European economy gathers steam from its post-crisis lows. Historically, European gas demand has seen an annual growth rate of about 0.9 times that of overall GDP growth. Depending on how the ongoing recovery unfolds, as we look out to 2020 and beyond, this likely implies an annual growth of gas demand of between 1 and 2 percent.
On another side, Europe’s indigenous gas supply looks set to contract over the same time frame. Conventional European gas production (ex Norway) looks like it will be in a state of decline over the coming decade. Especially significant is the peak and decline of the Netherlands’ Groningen field, which has been driving Dutch gas production since the late 50s.
Unconventional Supplies: Looking Doubtful
Last week we discussed hopeful developments in Dutch fracking. Holland is far from being the most richly endowed European nation in terms of unconventional gas supplies, but its long experience with natural gas, its prominence as a conventional gas supplier, and its better climate of public opinion suggest that it might be a place where shale gas production will be technically and politically feasible.
The picture for unconventional gas is not so bright across most of the rest of Europe, however. Poland was deemed the most hopeful candidate for unconventional production, and the regulatory climate is supportive, but drilling results have so far been disappointing, with the EIA downgrading reserve estimates and majors exiting the country.
In other European countries, the legislative and political climate is very negative. France, with high estimates for reserves, has put all unconventional exploration off the table, as have Germany, Bulgaria, and Romania. The government of the U.K. is making some slow progress in shifting negative public sentiment and still faces a difficult uphill battle.
The contraction of conventional domestic supply and the resistance to unconventional exploration means Europe will have to look elsewhere for gas. What are its options?
The table above shows Europe’s position, and sketches three scenarios for 2020, depending on projections of demand growth during the next 8 years. The most “pessimistic” scenario – with an annual demand growth of 2 percent, and no new approvals for U.S. LNG exports, shows a 36.3 BCMA short fall in supply. (The estimates above may also be making optimistic assumptions about the destination of U.S. LNG exports, as we discuss below – in which case the shortfalls become even more dramatic.)
Non to Coal, Nein to Nuclear
One way of looking at gas demand is schematically – in which it can be seen overall to have a historical relationship with GDP growth. But it’s worth noting other secular drivers of gas consumption. Foremost among these is the overarching sentiment of European governments that favor movement away from coal for power generation. Although price is still in coal’s favor, politics means that the slow phase-out of coal power generation is only likely to continue – albeit unevenly across different nations with different current capacities.
Nuclear power is also under popular pressure in the face of Japan’s far-from-resolved Fukushima disaster. Germany is planning a phase-out of all nuclear power by 2022. And in the absence of renewables that can really pick up the slack, relatively carbon-friendly gas is likely to be the go-to for replacement power generation.
Where Will the Gas Come From?
So the question is – as conventional gas supplies peak, and unconventional gas supplies remains locked up, where will Europe get the gas it will need as it moves back towards historical growth levels?
Norway will still be a major player, of course, and Statoil, the Norwegian state oil and gas company, will be a major beneficiary of Europe’s supply distress. Nevertheless, Norway’s capacity is less influential than that of Russia – which we’ll discuss below.
Liquid natural gas imports may figure prominently in the solution, but there are some caveats here. Non-U.S. LNG projects tend to suffer notable delays and to come online years after plan. U.S. gas suppliers seem to be making headway in winning approval for LNG exports, but there is still a contentious debate in the U.S. about exports and their possible derailment of the comparative advantage American manufacturers could reap from lower energy prices.
Asian Demand
The other giant caveat is... Asian demand. LNG shipped to Asia commands a significant premium over what is shipped to Europe, independent of shipping costs alone:
With LNG selling to Asia at these premiums, the pressure that Europe faces will depend on Asian growth – and recent data from Japan and China, for example, suggests that news arguing for a demise in Asia’s growth is incorrect.
Further, current expansion work on the Panama Canal will make Asian markets more accessible to U.S. LNG exports as they come on line. So projections of Europe’s gas future that rely heavily on U.S. LNG to fill their demand gap may turn out to be unrealistic.
Other Pipeline Sources
Another potential pipeline source for gas is the “Southern Corridor” pipeline which by 2019 will bring gas from Azerbaijan via Georgia and Turkey, then on to Greece, Albania, and Italy. The project has taken ten years to reach the point where all six nations involved have transit agreements – now the infrastructure has to be built out. This is a very promising long-term development, since by various pipeline connections it will have the ultimate possibility of connecting European pipeline systems to Iraq and other Middle Eastern sources. In the near-term, though, it is unlikely to be able to satisfy marginal European demand – by 2020 it is expected to provide 16 BCMA.
Further, the current crisis unfolding in Syria may have a significant gas-related geopolitical dimension. Gas suppliers in the Gulf such as Saudi Arabia and Qatar would like to build a pipeline through Syria and on to Turkey and Europe, but the Assad regime has been opposed. One major reason for the aid being given to Sunni insurgents in Syria by these Gulf regimes may be the hope that with Assad gone, this pipeline project might be able to go through.
In any event, this easing of the flow of cheaper pipeline gas to Europe through Syria is not well regarded by one of Syria’s last remaining international allies – Russia, which also happens to be the missing piece in our discussion of Europe’s puzzle.
Enter the Russian Bear
The one remaining element of the equation, and the one likely to be decisive in the near-term, is Russia. If European gas demand rises, indigenous supply falls, governments decide not to frack, pipeline buildouts are not complete, and LNG demand is high in Asia, Russia’s Gazprom is left as the swing supplier for Europe (with Norway’s Statoil playing second fiddle).
Many Europeans are concerned about this, of course, because Russian contract gas pricing is tied to oil prices rather than to spot market prices for gas. In the longer-term, Gazprom knows that it doesn’t want to squeeze too hard, as that will encourage the development of all the alternatives that so far have not materialized or that European governments have turned away from on doctrinaire grounds. But that longer-term is some way off – there’s plenty of room for Gazprom to squeeze in the meantime.
Russia Also Turns to the East?
Further, we see a longer-term reality in Russia. Russia has for centuries been ambivalent about its membership in the wider European cultural community. Its religious foundation was Byzantine, not Roman. Its connection to classical antiquity, the launch-pad of the modern world, was tenuous. The Enlightenment appeared in Russia as a graft of culture onto a part of the Russian elite, not as an organic growth of Russian culture itself. And when Russia finally overthrew its absolute monarchy, it replaced it with Stalinist absolute despotism.
Russia shows many signs that its hesitant turn to western values after the fall of Communism remains unstable because it’s not organically rooted in Russian culture. When Putin’s government advocates “majoritarian democracy,” and acts to defend Russian cultural norms with an official force viewed as illegitimate by the west, it’s a reminder that Russia has never been an essentially western nation. At the very least, Putin shows that Russia is continuing its long love-hate relationship with what the west has to offer.
And this is the nation that has an increasing lock on one of Europe’s critical energy sources. It is not the sort of geopolitical message that European leaders want to hear. Nevertheless, with what the almanacs suggest will be a cold winter ahead, and with a collection of questionable past policy choices under their belts, they don’t seem to have much of an option.
Gazprom is also looking east for its development and expansion opportunities. If Asian demand is a wildcard, China is the Joker. We believe Chinese growth will stabilize and continue to be strong as the nation navigates the current junction in its economic development.
The Quality of China’s shale gas reserves is uncertain, and domestic political pressure is rising to ease the pollution caused by its massive coal-fired energy production. China will certainly be interested in securing gas resources through a warming relationship with Russia as well as through the exploitation of their own shale reserves.
Implications: Europe Out in the Cold?
Who are the beneficiaries of Europe’s precarious gas position?
1) Gazprom and Statoil. Until medium-term developments of LNG and pipeline capacity, these two very different giants will reap the rewards of higher gas prices in Europe.
2) LNG players, especially in North America – if exporters win their political battles.
3) Pipeline infrastructure players, especially for the Southern Corridor pipeline from the Caspian.
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